How to Calculate EVA

EVA refers to economic value added and is a measure of how much a company or project has truly earned after taking the cost of capital into account. EVA equals net after-tax profits minus total cost of capital. The cost of capital is a composite number that is arrived at by averaging the rate at which shareholders expect and deserve to be compensated, as well as the interest rate on all borrowed funds. Positive EVA means that the company is a viable concern, while consistent negative EVA calls the long-term feasibility of the enterprise into question.

Companies produce goods and services in an attempt to add economic value.

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Calculating EVA

Assume a company has earned $100,000 and paid $15,000 in taxes. The after tax profit is $85,000. Further assume that the company is financed by $500,000 in shareholder equity and $400,000 in debt. The shareholders expect to earn 10 percent per year considering the risk profile of this business and the return they can earn from similar investments, while the loan carries an 8 percent interest rate. So the total cost of capital is 10 percent of $500,000 + 8 percent of $400,000, or $82,000. EVA equals $85,000 - $82,000, or $3,000. This is how much true value the company has added, over and above what the stakeholders could have obtained at prevailing market rates of return.